digital money

Digital Money. The Rise of a New Era

As an alternative to conventional forms of payment, digital money promises to speed up financial transactions and improve transparency. However, this emerging trend also brings a series of challenges, such as volatility and the risk of security breaches. So what should we think of this type of digital asset? What are the benefits, opportunities, and implications, and how far has its adoption advanced? In the following, we list five of the most important things to know regarding the rise of digital money.

Digital currencies are alternative methods of payment that exist only in electronic form and have no physical representation. Managed and transferred via online platforms, these currencies can also be exchanged via trading services and, in some cases, converted into their traditional physical cash equivalent via ATMs.

After being first conceptualized in 1983 by David Chaum, a US cryptographer, the concept of digital value transfer and digital cash only started to gain traction after Bitcoin was developed and became popular. Over a span of more than 20 years, the trend evolved slowly, with several failed attempts to introduce digital money into the market (e.g., DigiCash, the company that developed the first digital currency, eCash, went bankrupt in 1998).

Fast-forward another 20 years, and the trend is in full swing, with adopters and supporters from all levels of society, from governments to businesses and individual users. However, there are still many issues that need to be understood and addressed before the trend enters into the mainstream. Here are some of the main points to be aware of in relation to digital money.

Digital money comes in different shapes and forms

Even though terms such as “digital money”, “digital currencies”, and “cryptocurrencies” are sometimes used interchangeably, there are three main types of digital money, each with different characteristics in terms of centralization, encryption, and transparency:  

  • Cryptocurrencies are a form of digital money that is created using cryptography. Being supported by blockchain and unable to operate outside this platform, its purchasing power depends on its user community. On the one hand, this allows for complete decentralization, with no authorities or governments being involved from a regulatory perspective. On the other hand, this leads to high volatility and a limited legal framework. The strongest cryptocurrencies in terms of market capitalization and trading volume are Bitcoin and Ethereum.
  • Central Bank Digital Currency (CBDC) is a digital version of a country’s currency, backed by the central bank. It can be developed on different platforms (i.e., digital ledgers) and is therefore not limited to the blockchain (distributed ledger technology). The central bank retains control over the currency, issuing it and governing transactions. According to the Atlantic Council, 105 countries, representing over 95 percent of global GDP, are exploring a CBDC.
  • Stablecoins are digital money whose market value is tied to an external reference (i.e., another currency, the price of a commodity, etc.) and are developed in an attempt to counterbalance the high volatility of cryptocurrencies. There is a general trend towards tighter regulation of this type of currency. Tether (USDT) and U.S. Dollar Coin (USDC) are the strongest stablecoins in terms of market capitalization.

The market is moving fast

Currently, there are over 20’000 cryptocurrencies in circulation, the equivalent of US$1.07 trillion in market value. Based on a research study conducted by the Atlantic Council, ten countries have already fully launched a digital currency, 14 countries are currently conducting pilot projects to assess the feasibility and implications of digital money, 26 are in the process of developing the necessary systems and procedures, and 47 are still in the research phase.

Figure 1: Example of projects that explore the use of digital currencies (CBDCs) for retail, wholesale, and cross-border payments

On a global level, the Digital Currency Global Initiative, a joint project between ITU and Stanford University, aims to further explore the technical implications and challenges of digital money, develop metrics and means of standardization, and promote best practices and learnings from pilot implementations.

The number of technology and service providers for digital currencies is increasing

A significant number of fintech companies that develop platforms or solutions for digital currencies have been founded in the last decade. Either leveraging the distributed ledger technology or blockchain-agnostic, these companies aim to provide central banks, financial institutions, governments, and participants in financial transactions with the necessary tools to implement and use digital currencies.

Figure 2: Number of companies founded between 1983-2021 that develop technologies or services for digital money (source: CrunchBase)

Companies such as FTX US (former LedgerX) and BiKi.com provide platforms for digital currency trading services. Bitt, TradeBlock, and Fluency develop solutions that help wholesale or retail customers to develop, customize, and integrate digital financial instruments, while companies such as Coinfirm focus on facilitating regulatory and compliance processes. The market of solution providers is constantly expanding, covering all aspects from technological enablers to exchange platforms and regulatory systems.

A society governed by digital money comes with additional challenges

Despite the promise of digital money to increase access to payments, efficiency, and resilience, the road to mainstream digital currencies is not a smooth one. First, a consistent and unitary legal framework still needs to be developed, and all parties involved need to reach a mutual agreement. The amount of human and financial resources for scaling up the pilot projects is also considerable (e.g., a lack of resources was the reason why Uruguay has not launched its second digital currency project).

As with most emergent technologies, digital money is not yet entirely accepted by consumers due to concerns related to privacy and safety. To a certain degree, these fears are justified, with digital assets being more vulnerable to cyberattacks than traditional money. On top of that, due to uncertainty over the technology and questions as to whether the technology is fully scalable and can meet the demands of a large population, the path to full adoption could still be a long one.  

Moreover, some critics see CBDCs as a “slippery slope” leading to economic influence and social control by the state. They believe the centralized version of digital money would give governments the opportunity to control spending, allow only certain purchases, and provide money with expiry dates which would allow them to force private citizens to spend their money instead of saving it.

Digital money will significantly disrupt the financial sector

There are multiple scenarios for the future of financial services in relation to the digitalization and decentralization trends. Many experts are inclined to predict a future coexistence of physical and digital money, while others point towards complementarity – with each type of currency having its unique role in financial transactions. However, there are also supporters of the takeover scenario, where physical money is entirely replaced by its digital counterparts.

Either way, the financial sector has to develop contingency plans and adjust to changes related to business models (e.g., changes in the product and services demand and offering), regulation and compliance, infrastructure adjustments, identity management, cybersecurity, audits, and financial reporting, as well as employee capacity building.

Although the popularity of digital currencies is constantly growing, they are not yet widely perceived and accepted as a reliable and secure alternative to physical money. However, the trend is currently gaining ground and is expected to gain increased traction in the near to medium future.

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Catalina Sparleanu

Working with top experts to identify how the latest innovations and disruptive technologies will impact businesses, industries, and society. I have an academic background in social science (Ph.D. in Sociology), an MBA degree, and experience in private companies and NGOs.

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